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Market Valuation


Shane

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How many of you follow Shiller's PE?

 

Judging by this method the market has been overvalued for a while now...  What other methods are there to monitor market valuations?

 

Parsad and Buffett seem to both be of the opinion that the market is not overvalued and judging by Buffett's buying spree he might even be of the opinion that the market is undervalued.

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How many of you follow Shiller's PE?

 

Judging by this method the market has been overvalued for a while now...  What other methods are there to monitor market valuations?

 

Parsad and Buffett seem to both be of the opinion that the market is not overvalued and judging by Buffett's buying spree he might even be of the opinion that the market is undervalued.

 

I am not sure about your conclusion. Individuals finding undervalued securities might not translate to whole market being undervalued.

 

I don't think the market is undervalued by decent margin even if it is undervalued. I would think that it is over valued a bit but you can find many large comanies selling at good price. Having said that, I don't use market valuation guess to make my investment decisions so take my opinion accordingly.

 

I don't have any opinion about Shiller's P/E ratio but you can use one more ratio used by Buffett time to time. In his 2001 Fortune magazine article, Warren Buffett used the ratio of the market value of all US publically traded securities to Gross National Product (GNP) as a yardstick to measure the stock market valuation. He stated that 

 

"The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment".

 

"If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire".

 

 

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Ericopoly - good point there, much appreciated.

 

rranjan - I had some trepidation when referring to whether or not Buffett thought the market was undervalued. 

 

I am currently building a list of high quality companies that I would like to buy in the instance they are priced low enough...  I doubt any of these firms will hit my prices unless the market as a whole becomes undervalued or a unique situation occurs.  I think keeping an eye on overall market valuations could be beneficial if I were to ever buy into these firms.  Learning about long term valuation trends could help me put things into perspective.

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Somewhat off topic, but while we are talking about the general market evaluation, would anyone care to share their opinion on why the average market valuation over the last 30 years is justifiably higher in some investors minds?  I've heard Joel Greenblatt use only the last 20 years to say that "compared to the last 20 years, todays market valuation is in the 90% of cheap".  Why would he use only the last 20 years, when he knows that those 20 years have been historically overpriced? Is there a reason why the Shiller P/E  should be seen as PE of 20 = fair valued, instead of the normal(for the last century): PE of 15 = fair valued?  I've heard that with the introduction of fiat money, the market deserves a higher PE, but i'd like to hear other peoples thoughts.

 

 

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Somewhat off topic, but while we are talking about the general market evaluation, would anyone care to share their opinion on why the average market valuation over the last 30 years is justifiably higher in some investors minds?  I've heard Joel Greenblatt use only the last 20 years to say that "compared to the last 20 years, todays market valuation is in the 90% of cheap".  Why would he use only the last 20 years, when he knows that those 20 years have been historically overpriced? Is there a reason why the Shiller P/E  should be seen as PE of 20 = fair valued, instead of the normal(for the last century): PE of 15 = fair valued?  I've heard that with the introduction of fiat money, the market deserves a higher PE, but i'd like to hear other peoples thoughts.

 

Perhaps because there is more demand for investments (e.g., more money from 401k plans or retirement accounts)?  It seems to me that we are still regressing in terms of P/Es, but maybe we've reached the end of that for now.

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Burke doesn't understand the concept of hedging, thus he would not understand the concept of hedging out the market risk embedded in an investment program centered on purchasing publicly-traded equities. Those buying a whole businesses have the luxury of being able to ignore market risk because the ROI is generated via taking cash out of the business - inversely, those buying whole businesses do not have the luxury of the marketplace re-rating their investment.

 

Private buyers, private equity and activists have an embedded hedge in their operations due to the control they are able to exert on the investment, thus their operations are not directly comparable to those on this board who no doubt do not have a controlling position in their holdings.

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Hedging has everything to do with it. If your company doesn't get taken out, then you've hedged the risk of the stock declining in value along with the general market. You know, there is an entire industry predicated on the concept of hedging....

 

Michael Price invests in special situations as well as general undervalued situations because the special situations are uncorrelated with the market (see: http://www.dailymarkets.com/stock/2010/05/05/michael-price-resource-page-complete/). Why would he invest in something that is uncorrelated with the market if he doesn't at all care about the market?

 

Here are Walter Schloss's investment guidelines (take note of #9) (link here: http://www.gurufocus.com/news/138200/walter-schloss-the-essence-of-value-investing):

 

Factors needed to make money in the stock market:

 

•1 - Price is the most important factor to use in relation to value.

•2 - Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.

•3 - Use the book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).

•4 - Have patience. Stocks don’t go up immediately.

•5 - Don’t buy on tips or for a quick move. Let the professionals do that, if they can. Don’t sell on bad news.

•6 - Don’t be afraid to be a loner but be sure you are correct in your judgement. You can’t be 100% certain but try to look for weaknesses in your thinking. Buy on a scale and sell on a scale up.

•7 - Have the courage of your convictions once you have made a decision.

•8 - Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.

•9 - Don’t be in too much of a hurry to sell. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock a goes up say 50%, people say sell it and button up your profit. Before selling try to reevaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high? Is the stock market historically high? Are people very optimistic etc?

•10 - When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. Three years before the stock sold at 20 which shows there is some vulnerability to it.

•11 - Try to buy assets at a discount [rather] than to buy earnings. Earnings can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.

•12 - Listen to suggestions from people you respect. This does not mean you have to accept them. Remember it’s your money and generally it is harder to keep money than to make it. Once you lose a lot of money it is hard to make it back.

•13 - Try not to let your emotions affect your judgement. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.

•14 - Remember the work of compounding. For example, if you can make 12% a year and reinvest the money back you will double your money in six years, taxes excluded. Remember the rule of 72. Your rate of return [divided] into 72 will tell you the number of years to double your money.

•15 - Prefer stocks over bonds. Bonds will limit your gains and inflation will limit your purchasing power.

•16 - Be careful of leverage. It can go against you.

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hahah classic - diverting the conversation.

 

I'm for hedging and you are against it, simple as that. All I am doing (and have done) is point out that very prominent investors hedge in some way shape or form. None of them completely ignore risk as you would like to lead everyone to believe.

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"Somewhat off topic, but while we are talking about the general market evaluation, would anyone care to share their opinion on why the average market valuation over the last 30 years is justifiably higher in some investors minds?  I've heard Joel Greenblatt use only the last 20 years to say that "compared to the last 20 years, todays market valuation is in the 90% of cheap".  Why would he use only the last 20 years, when he knows that those 20 years have been historically overpriced? Is there a reason why the Shiller P/E  should be seen as PE of 20 = fair valued, instead of the normal(for the last century): PE of 15 = fair valued?  I've heard that with the introduction of fiat money, the market deserves a higher PE, but i'd like to hear other peoples thoughts."

 

I remember the comment of Munger who said that in the past the market has been horrible mispriced on the downside and now it seems that people have gotten a little bit more rational and price the market a little bit more efficient.

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hahah classic - diverting the conversation.

 

I'm for hedging and you are against it, simple as that. All I am doing (and have done) is point out that very prominent investors hedge in some way shape or form. None of them completely ignore risk as you would like to lead everyone to believe.

 

really did Paulson hedge last year? Did BB hedge last year? Why don't you tell people how much it cost the Shiller disciple in "lost wealth" as they hedged out market risk the last 20 years? what you fail to tell people is that if you hedge out market risk it can COST you, in frictional costs and performance. There is cost to being an academic, not to mention they almost blew up the global economy and had to have j6p (who did not go to Wharton) bail them out.

 

Again, diverting. Dan Loeb hedged. David Einhorn hedged. BB CAN'T HEDGE. Baupost is not fully invested. Howard Marks is not fully invested. Of course there is risk to hedging - there's also risk to being 100% long. The trick is to know when to hold 'em, and when to fold 'em. Buffett knew to fold 'em in the late 1960's - my guess is there were many investors worried about missing the next upleg in the market when WEB was getting out. Grantham lost a ton of business in the late 1990's by turning bearish years before the market top. Pretty sure we all know how that has turned out for him.

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I was referring to shorting with regard to BB.

 

It's a portfolio management decision. Greenblatt's strategy of bottoms-up stock picking got CRUSHED in the downturn. Pabrai got CRUSHED in the downturn utilizing "bottoms-up" without hedging. I'm not on a limb here worrying about market risk.

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I do an update every month on eight valuation metrics. I have been doing one for two years and it has evolved. I discuss Shiller pe in depth. Please let me know your thoughts http://www.valuewalk.com/category/stock-market-valuations/http://www.valuewalk.com/2011/01/stock-market-valuation-january-2012/#.TwtScm-CkhV Steven Romnick looks at market valuations. I also have Europe here- http://www.valuewalk.com/2012/01/european-stocks-are-now-half-as-expensive-as-us-equities/very cheap, even Norway.

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"Somewhat off topic, but while we are talking about the general market evaluation, would anyone care to share their opinion on why the average market valuation over the last 30 years is justifiably higher in some investors minds?  I've heard Joel Greenblatt use only the last 20 years to say that "compared to the last 20 years, todays market valuation is in the 90% of cheap".  Why would he use only the last 20 years, when he knows that those 20 years have been historically overpriced? Is there a reason why the Shiller P/E  should be seen as PE of 20 = fair valued, instead of the normal(for the last century): PE of 15 = fair valued?  I've heard that with the introduction of fiat money, the market deserves a higher PE, but i'd like to hear other peoples thoughts."

 

I remember the comment of Munger who said that in the past the market has been horrible mispriced on the downside and now it seems that people have gotten a little bit more rational and price the market a little bit more efficient.

 

Charlie,

 

Maybe they see the market cheaper than historically, even with a relatively higher p/e (as per Shiller) because of the general level of interest rates. Compare earnings yields (the inverse of p/e) to bond yields and cash yields over time. They tend to move together. Not necessarily at the same level, but they do correlate over time as they effectively compete with one another. Since 1981/2, interest rates have declined and p/es have, in fits and spurts, risen. Meaning earnings yields have fallen in line with other interest rates. But, over the last few years, p/es have declined, moreso than might seem justified given where other interest rates are.

 

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Jacob that first link came up "Page not found"

 

Your european page is very informative though.  I wish that P/S or EV/EBITDA was more widely available as I think these could be more useful to compare companies with different accounting practices.

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Jacob that first link came up "Page not found"

 

Your european page is very informative though.  I wish that P/S or EV/EBITDA was more widely available as I think these could be more useful to compare companies with different accounting practices.

 

Thanks I do the European ones also every month. I have more carts if you want. I also wish p/b, p/s, EV/EBITDA was available more for American markets.

 

There was a wierd problem with that article. Its on my homepage right now as a sticky bc it has disappeared in the archives http://www.valuewalk.com/

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Guest Hester

Yes, yes another thread "won" by the great Burke. Congrats  8)

 

He won by default as soon as he used the phrase "what a bunch of malarky." The rest was just post game celebration.

 

 

 

 

 

what a bunch of malarky.

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I guess I'm asking, does anyone seriously think we will see a time again, like 1974 where the 10 year P/E was close to 5 (and other metrics were much lower than the worst of 2009 as well, including buffett's favorite..in 1974, i believe market valuation to gdp was like 40%, much lower than it ever hit in 2009.)

 

it seems to me like these days are gone, and the market is valued consistently higher.  I'm just not sure of the fundamental reasons why this might be true. 

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"it seems to me like these days are gone, and the market is valued consistently higher. "

 

Well, I thought the exact same thing about net-net stocks reading The Intelligent Investor from Benjamin Graham in 1998. Then a multitude of them appeared in 2008 and 2009. So I would not rule out another leg down say 4-5 years out when earnings will be higher than today, but morale very low and giving you once again 1974 valuations.

 

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